Sept. 9, 2013 – A circuit court declined to offset priority interests, known as the “doctrine of marshaling assets,” to help a subordinate creditor who did not obtain personal guarantees for commercial real estate loans. Recently, a state appeals court affirmed.

Vespera LLC, a real estate development firm, purchased several lots from Briarwood Club LLC to develop a restaurant and condominiums in Oconomowoc.

Vespera obtained a $2.9 million dollar loan from First Bank Financial, which secured the loan with a first mortgage on the property. First Bank also obtained personal guarantees from Vespera’s individual members, who pledged real estate and corporate stock.

Briarwood loaned an extra $900,000 to Vespera and took a mortgage on the property that was subordinate to First Bank’s mortgage. Later, Waterstone Bank entered the scene. Waterstone loaned Vespera $6.135 million for the development project.

With this money, Vespera paid its $1.92 million balance to First Bank. Waterstone secured its loan with a mortgage on the property and obtained the same personal guarantees from Vespera’s members as First Bank: real estate and corporate stock.

Then Vespera defaulted on the loans. Briarwood obtained a $1.2 million foreclosure judgment; Waterstone a $5.1 million judgment.

Waterstone expected to recover $1.89 million in personal guarantees, but a sheriff’s sale was not expected to cover the remaining judgment balances.

Briarwood sued in equity for application of the “doctrine of marshaling assets,” which allows courts to offset priority interests when two creditors are involved.

Specifically, the doctrine “provides that when one creditor has an interest in two funds or properties held by a debtor, and another creditor to the same debtor has an interest in only one of those funds or properties, a court may order the creditor with two funds to satisfy its claim out of the fund unavailable to the other creditor,” according to the three-judge panel in Briarwood Club LLC v. Vespera LLC, 2012AP2105 (Sept. 4, 2013).

Briarwood wanted Vespera’s personal guarantees to satisfy the $1.92 million priority interest that Waterstone held in the Vespera property. Under the doctrine of equitable subrogation, Waterstone obtained this priority interest by paying off First Bank.

“The effect would be that Waterstone would recover the first $30,000 rather than the first $1.92 million generated by the sheriff’s sale of the Vespera property,” Judge Paul Reilly explained. “It would also mean that Briarwood would collect up to its full judgment before Waterstone can begin recovering the remaining $3.18 million outstanding on its judgment.”

But the appeals court refused to apply the doctrine of marshaling assets to this situation, because application would hurt Waterstone.

“The doctrine does not operate equitably if it diminishes the debt position of the senior creditor,” Judge Reilly wrote. “Briarwood could have sought personal guarantees; the fact that it did not, while Waterstone did, should not operate to Waterstone’s detriment.”